Discussions regarding the appropriate measure of the real exchange rate (RER) are surrounded by controversy. Classically, there are at least two ways of calculating the RER: (1) the simple real exchange rate (RERS); and (2) the Purchasing Power Parity real exchange rate (RERPPP). Of these two measures, the RERPPP has usually been seen as more appropriate because international arbitrage does not exist in non-traded goods sectors. However, both measures assume that the RER is based only on the flow of goods, services and net factor incomes between countries. In the long run, however, the real exchange rate is also based on capital flows because the long-run capital account need not be in balance. In response to this observation, new macroeconomic approaches to better describe an equilibrium real exchange rate (ERER) have emerged. Following the work of economists Romain Duval and Jerome Stein, this thesis tests the Natural Real Exchange Rate (NATREX) Model, a theoretical model which relies upon a single cointegrating relationship between the real exchange rate and its long run fundamentals to provide a moving ERER on a trajectory from the medium to the long run. Unlike most studies which have looked at only one or two country pairs at a time, we use data from 15 OECD countries and a uniform methodology across the set to estimate quarterly bilateral ERERs, using the United States as the base country. The results of this test are mixed, suggesting that consistent estimates of the long run NATREX ERER may be difficult to estimate.
Freeman, Rebecca, "Testing the NATREX model : long-run fundamentals and the dynamics of equilbrium real exchange rates" (2009). Theses, Dissertations, and Projects. 1453.